MARKET-TIMING OF STOCK PRICE INFORMATIVENESS IN FIRM’S STOCK REPURCHASE: A SYSTEMATIC REVIEW
Chee Chong Menga, Nazrul Hisyam Bin Ab Razakb
aFaculty of Business and Finance, Universiti Putra Malaysia, Malaysia, Email: (corresponding author)
bFaculty of Economics and Management, Universiti Putra Malaysia, Malaysia, Email:
Abstract
The objective of this review paper is to compile and gather all literatures and empirical findings for discussion of the new aspect of market-timing of repurchase which is the use information content of stock price (stock price informativeness) in timing firm’s stock repurchase. Despite numerous empirical researches focusing only the market-timing theory and finding the presence of market-timing of stock repurchase, and looking at that new aspect, the researchers contend that the success of managerial market-timing would be attributed to the effect of stock price informativeness based on managerial learning hypothesis, which managers can learn information from stock price to make better decision. It is believed that managers possess market-timing ability with the tool of stock price informativeness to take advantage of stock market. The contributions of this review paper are to: identify literature and theoretical gap in repurchase studies; discuss some causes on the effect of stock price informativeness on firm stock repurchase decision; and serve as a theoretical foundation for future empirical research.
Keywords: Open market repurchase, information content of stock price, stock priceinformativeness, informed trading, firm-specific stock return variation, price non-synchronicity
1. Introduction
A stock repurchase is beneficial to shareholders as firm’s earning distributed by fewer shares to shareholders as if owning a bigger stake of ownership in a firm without having to buy more stock. Although earnings per share does not increase in lockstep with share prices, they are closely related, which has helped to sustain the stock market rally going even in a slow-growth environment. As can be observed in United States companies which pick up their own shares at bargain prices in the past few years. Throughout 2013, 431 of the 500 companies in Standard & Poor's 500-stock index have repurchased their own shares, retiring $448 billion in equity (Kristof, 2014). Such buyback spree has rewarded shareholders both directly and indirectly. There was increasing stock buyback after the U.S. subprime mortgage crisis since 2009 and have been shown mild decline or perhaps stabilize in 2016 (Birstingl, 2016).
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Since the past few decade, research work has been devoting to observe and examine post-repurchase performance, reaction or response of stock price as well as stock price behavior after the firm stock repurchase. Based on repurchase literature and empirical evidence, firm repurchase or buyback stock for several motives: signaling undervaluation, price support and others [need citations]. Furthermore, several research hypotheses on repurchase such as cash flow hypothesis, signaling theory and market-timing theory are discussed in repurchase literature or tested in empirical evidence. Particularly, the presence of market-timing theory is evidenced in some research findings (Brockman & Chung, 2001; Konan Chan, Ikenberry, & Lee, 2007; Dittmar & Field, 2015; Yook, 2010), nevertheless it is still controversial on the presence of market-timing skills on repurchase as no such evidence found in some empirical research (Ginglinger & Hamon, 2007).
Though insider possessing more information than outsider that being well-accepted in finance literature, another growing strand of literature assert that outsiders possess information that manager do not and manager learn that information (Chen, Goldstein, & Jiang, 2007; Durnev, Morck, & Yeung, 2004; Dye & Sridhar, 2002; Foucault & Frésard, 2012; Fresard, 2012; Luo, 2005). The information mechanism underlying managerial learning derives from the well-established idea that diverse pieces of information aggregated and transmitted into stock prices via the trading activities of a myriad of different investors and speculators (Fresard, 2012). The usefulness of information content of stock price and the managerial learning hypothesis has become an intriguing research areas and start to draw research attention. In fact, a recent strand of empirical evidence supports managerial learning hypothesis that indicate manager learn information from stock price when making investment decision (Ben-Nasr & Alshwer, 2016; Chen et al., 2007) and corporate finance decision (Kalok Chan
Chan, 2014; De Cesari & Huang-Meier, 2015). Luo, (2005) opined that the presence of managerial learning hypothesis is not only applied in merging and acquisition but also other corporate finance decision such as stock repurchase, stock issuance, corporate strategy change and the appointment of top managers. Based on that reasoning, it leads the researchers to suspect that success of managerial market-timing in repurchase could be associated with information learned from the stock price.
A question whether of how would the information content of stock price would affect managerial market-timing of repurchase has never been studied thus far. This paper intends to review how stock price informativeness affect corporate finance decision and discuss the potential effect of stock price informativeness to stock repurchase. To the best of our knowledge, this review paper is the first to discuss potential relationship between stock price informativeness and firm stock repurchase. contribution of this review paper is twofold. Firstly, it documents an insight on how manager exploit the information they learn from the stock market when decide on repurchase, this paper adds to the growing literature on managerial learning. Secondly, the informational role played by stock price on firm stock repurchase determine when manager should buyback or not, this paper helps to bridge this gap theoretically. By developing strong theoretical knowledge, this paper supports future empirical research to empirically assess managerial learning hypothesis that applied in firm stock repurchase. Such evidence is very crucial to managers and practitioners as it will have a great implication on the improvement managerial market-timing skill in their stock repurchase using informational content of stock price.
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2. Review on Informational Content
Stock returns fundamentally reflect to new market-level and firm-level information capitalized into stock prices. French & Roll (1986) & Roll (1988) suggest that a significant portion of stock return variation is not attributable to general market and industry movements and suggests that these residual movements represent the impounding of firm-specific information into prices. A process of incorporating information into stock price is continuous from time to time. Roll (1988) shows firm-specific variation is largely unrelated with public announcement but due to trading by investors with private information. The less firm-specific impounded into the firm’s stock price, the lower firm-specific variation of stock price leads to higher correlation between stock returns and market returns, thereby indicating higher level of stock price informativeness in other words higher stock price synchronicity. If the more reflective of stock price to firm-specific information firm’s stock price will have less synchronous movements (low level of stock price informativeness). Thus, firm-specific variation in stock prices serves as the inversed measure to the both terminologies. Pertinently, higher the firm-specific variation in stock prices indicates lower future level of stock price informativeness. Stock price informativeness or stock return non-synchronicity is commonly used to gauge the amount of firm-specific information impounded in stock prices, supported by considerable empirical researches in finance (Bai, Hu, Liu, & Zhu, 2017; Ben-Nasr & Alshwer, 2016; Kalok Chan & Chan, 2014; Crawford, Roulstone, & So, 2012; De Cesari & Huang-Meier, 2015; Ferreira, Ferreira, & Raposo, 2011; Fresard, 2012; Vo, 2017). These studies argue that firm specific return variation is a good proxy which reasonably measures the rate of private information incorporated into prices via trading.
3. Information: Insider vs Outsider
There is a well-developed finance literature to advocate that corporate insiders are superior in knowing more about their firm or possess more information than outsiders. Effects and implications of corporate insider trading are also well-documented in the literatures. Having say that, another strand of theoretical literature in corporate finance has argued that managers can learn from the information in stock price about the prospects of their own firms and embedded this notion into their empirical model (Dow & Gorton, 1997; Dow & Rahi, 2003; Dye & Sridhar, 2002; Goldstein & Guembel, 2008; Subrahmanyam & Titman, 1999). Most recent literature has pursuing that research paradigm that stock prices may contain some information that managers do not possess.
It is undeniably possible yet reasonable that corporate outsiders perhaps possess information that is unknown to insiders. That piece of information could allow this latter group to make more informed and better decisions. This argument should not be ruled out. More generally, capital market participants who are specialized in valuation such as investment bankers, professional fund managers, investment analyst, industrial experts and financial journalists are superior than firms at analyzing and interpreting publicly-available information in multi-perspectives, often more superior to firms by looking things at broader view and producing useful private information from analysis. (Dye & Sridhar, 2002). What has been usually accepted is that the institutional investors who have enough skills and sophistication to form accurate
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forecasts as the information environment of a firm improves (Farooq & Hamouda, 2016). Chan & Hameed (2006) find securities covered by more analyst incorporate greater market-wide information and increases of stock price informativeness come with greater analyst coverage. Furthermore, firms often seek for and recruit advisors, consultants and expertise to attain information that could be crucial and significant in the decision-making process. In addition to that, advancement of information technology and system make financial database available and accessible for analysis and research, is a catalyst to information production.
4. Managerial Learning Hypothesis
An important channel for manager obtaining novel information on their firm is based on the observation of the level and dynamics of the firm's valuation on secondary financial markets (Bond, Edmans, & Goldstein, 2012). The managerial learning hypothesis suggests that managers can learn new private information from their stock prices that helps improving their decisions efficiency (Ben-Nasr & Alshwer, 2016; Kalok Chan & Chan, 2014; Chen et al., 2007; Fresard, 2012; Hayek, 1945), hence increases the value of the firm. In fact, managers use all available information, which contains their own private information and investors' private information capitalized in stock price, to decide level of investment that maximizes the expected value of their firms (Foucault & Frésard, 2012).
- Review on association between stock price informativeness and corporate finance decisions
Some prominent theoretical researches embed managerial learning theory into their research theoretical framework or model to study effect of stock price informativeness in different context of corporate finance decision making: investment (Dow & Gorton, 1997; Dow & Rahi, 2003; Foucault & Gehrig, 2008; Strobl, 2014), merger and acquisition (Luo, 2005). Together with some growing empirical evidences support the managerial learning hypothesis that managerial decisions reply in part on information conveyed in stock prices. To the best of our knowledge, only these empirical researches associating stock price informativeness with corporate finance decision are found available hitherto in finance literature, as shown in the following table:
Table: Literature review matrix on the effect of stock price informativeness on corporate finance decisions
Author / Research Objective / Measure of stock price / Findings:informativeness (SPI) / Effect/
relationship
(Durnev / To find relationship / / Firm-specific stock / Positive
et al., / between stock price / return variation
2004) / informativeness (SPI) and
efficiency of corporate
investment
(Luo, / To examine relationship / / High-tech status / Positive
2005) / between SPI and mergers / / Bidders size
& acquisitions (M&A)
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decision
(Chen et / To test effect of SPI on / / Price nonsynchronicity / Strong positive
al., 2007) / investment sensitivity to / / Probability of informed
stock price / trading
(Wang, / To find linkage between / / Firm-specific stock / No
Wu, & / SPI and firm level / return variation
Yang, / investment in China
2009)
(Foucault / To study effect of SPI on / / Firm-specific stock / Positive
investment decision / return variation
Frésard, / among cross listed firms
2012)
(Fresard, / To determine whether / / Firm-specific stock / Positive
2012) / manager use SPI to decide / return variation
on corporate cash saving / / Amihud Illiquidity
ratio
/ Llorente private
information trading
measure
(Chan & / To analyze effect of SPI / / Price nonsynchronicity / Negative
Chan, / on the pricing of seasoned / (firm-specific stock
2014) / equity offering (SEO) / return variation
(Zhu, Jog, / To test SPI (reflected by / / Firm-specific stock / Positive
idiosyncratic volatility) / return variation
Otchere, / and M&A decision / / Idiosyncratic volatility
2014)
De Cesari / To examine the effect on / / Firm-specific stock / Positive
& Huang- / SPI on of dividend / return variation
Meier / changes / / Amihud Illiquidity
(2015) / ratio
/ Probability of informed
trading
Ben-Nasr / To investigate impact of / / Firm-specific stock / Positive
SPI on labor investment / return variation
Alshwer / efficiency / / Amihud Illiquidity
(2016) / ratio
/ Probability of informed
trading
Observed from the review matrix above, recent researches have intended to answer whether managerial learning assists in making more informed corporate finance decision which varies ranging from investment to merger & acquisition. In term of construct, more generally, firm-specific stock return variation is adopted to measure stock price information.
With respect to investment decision, Durnev, Morck, & Yeung (2004) show that more informative stock prices help improving investment efficiency. Similarly, Chen,
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Goldstein, & Jiang (2007) report evidence suggesting that stock price informativeness is associated with higher investment-stock price sensitivity, hence more efficient investment. Foucault & Frésard (2012) finding, which supports managerial learning hypothesis, indicates higher investment sensitivity to stock price with its large sample of US cross listing firms and they address that stock price informativeness affect other corporate decisions. Nevertheless, Wang, Wu, & Yang (2009) found no relationship between stock price informativeness and investment decision yet they address their finding due to substantial government ownership in many listed firms in China that dampens free trading. In the context of M&A, positive impact of stock price informativeness found by Luo, (2005) though other proxies of gauging stock price informativeness employed, unlike the literature suggesting firm-specific stock return variation. Similar finding (positive) found in Zhu, Jog, & Otchere (2014), their finding indicate that acquirers who are informationally disadvantage are likely to take over other firm and pay higher premium.
In terms of other corporate finance decision, Fresard (2012) shows that higher stock price informativeness improves the efficiency of corporate savings decisions. Chan & Chan (2014) studies the effect on seasoned equity offering and found negative relation between stock return synchronicity and discount of Seasoned Equity Offering (SEO). The negative relation is strongest when there is no analyst coverage, and it declines as analyst coverage increases. With respect to the effect of stock price informativeness on dividend policy, De Cesari & Huang-Meier (2015) adopt firm specific variation as a measure of private information and find positive relationship between stock price informativeness and dividend changes. Their finding suggest that managers learn new information from stock price when deciding dividend policy. Ben-Nasr & Alshwer (2016) find evidence of usefulness of stock price informativeness on labour investment efficiency. These theoretical work and empirical evidences discussed provide us some clues or insights on potential formulation of association between stock price informativeness to repurchase decisions.
6. Association between stock price informativeness and stock repurchase
Relating to the afore-discussed repurchase literature, this review paper would like to draw research attention on the effect of stock price informativeness on market timing of repurchase. The researchers contend that information that managers already had will move the price as it already affected the past repurchase but not affect the current repurchase decision. Information that manager do not have (in other words, private information from firm’s stock price) could affect the current repurchase decision. That argument of how timing of information affecting corporate decision is similar to the assertion by Chen, Goldstein, & Jiang (2007). Based on this reasoning, it is suspected that positive relationship between repurchase sensitivity to firm’s stock price and the amount of private information incorporated into the firm’s stock price by speculators would imply that the private information in firm’s stock price is new and novel to managers and that managers observe at the stock price to learn this information and adopt it in timing stock repurchase.
Coupled with some reasons that could plausibly explain how stock price informativeness can affect managerial stock repurchase in several ways: First, stock prices convey private information that managers do not possess such as information
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about future investment and growth opportunities (Dow & Gorton, 1997), future demand of the firm's products and services, and financing opportunities (Subrahmanyam & Titman, 1999), resource allocation (Dye & Sridhar, 2002), thus all these guides manager in making repurchase decision (Luo, 2005). Second, more informative stock prices are associated with better external and/or internal monitoring of managers (Ferreira et al., 2011; Holmstrom & Tirole, 1993) and lower agency cost (Strobl, 2014), hence mitigate the potential overpaid in buyback (i.e., buyback at underpriced) or avoid unnecessary buyback. Third, lower of stock price informativeness (lower firm-specific variation of stock price) is the outcomes of more disclosures, transparency, better governance environment and a higher quality of financial reporting (Dasgupta, Gan, & Gao, 2010; Farooq & Hamouda, 2016; Hutton, Marcus, & Tehranian, 2009; Jin & Myers, 2006), which alleviate information asymmetries and improve informed trading (Fernandes & Ferreira, 2009), hence promote price correction from undervaluation and price efficiency. As the higher information asymmetry, it strengthens the sentiment-driven mispricing effect (Liang, 2016). Stock price informativeness is higher in less informative environment since more private information impounded into stock price by speculators, the researcher argue that these allows managers to be superior in timing their stock repurchase. Given no research been conducted thus far, it is intriguing to have deep insight on relating stock price informativeness and managerial market timing repurchase, it would be meaningful for the future empirical research in the particular context of stock repurchases.